Business Valuation Glossary
It is the process of determining a firm's economic worth.
What is Business Valuation?
Determining a firm's economic worth is the process of doing a business valuation, commonly referred to as a company valuation.
It takes a great level of competence to execute company valuation services, and the valuation professional has a responsibility to explain the valuation process and result in a way that is transparent and truthful.
A company's fair value can be established through a company valuation for several purposes, such as sale price, determining partner ownership, taxation, and even divorce processes.
The definitions for the terminology in this glossary were developed in cooperation with the mentioned listed groups and organizations below:
- American Institute of Certified Public Accountants - AICPA
- American Society of Appraisers - ASA
- Canadian Institute of Chartered Business Valuators - CBV Institute
- National Association of Certified Valuators and Analysts - NACVA
- The Institute of Business Appraisers - IBA
- Royal Institution of Chartered Surveyors - RICS
The most crucial terms to understand when valuing a firm are included in this glossary of business valuation terms.
Business Valuation Glossary
Some commonly used terminologies and definitions are discussed below.
Adjusted book value
It’s a way to determine the value of a business by deducting total assets from intangible assets and liabilities.
As its name suggests, all assets and obligations are adjusted to their market value. This technique is used to give value to companies that are encountering liquidation.
Alpha
This is a term used to assess the performance of a stock (compared to a suitable benchmark). Alpha is generally referred to as the active return on investment, and it serves as a metric to determine how an investment performs against the market as a whole.
It indicates if the stock or investment has outperformed or underperformed in the market.
All risk yield (ARY)
ARY is a metric often used in the real estate industry to gauge the underlying property's annual rent revenues. When calculating yields, investors divide only the income ROI by the investment’s value to measure how much income they can make annually.
Attrition
Attrition is the annual rate of the company’s asset shrinkage, such as losing employees without replacement. Layoffs are a better way to downsize the staff and minimize payroll.
The attrition rate can be used to anticipate the future cash flows of a similar asset.
Basis of Value
The basis of value is a declaration of a valuation's fundamental measurement assumptions. Additionally, these standards provide the right foundation (or bases) of value for many typical valuation uses.
Beta
Beta is a concept that measures the volatility of a stock in comparison to its benchmark. It's a metric for determining the equity costs utilized in a valuation technique.
Capital Asset Pricing Model (CAPM)
CAPM is a financial model where the cost of capital for every security or portfolio of securities is equal to the risk-free rate plus a risk premium that is commensurate with the systematic risk of the security or portfolio.
A size premium, a country-risk premium, or a company-specific risk premium may also be added if necessary.
Cashflow
Cashflow is the cash movement in and out of business (Inflows are the money received & outflows are the money spent). It is calculated by deducting the opening balance from the closing balance.
Cost Approach
The cost approach is one among three real estate valuation techniques to estimate the market value of a new property by calculating the cost of reconstructing an equivalent structure.
This strategy is based on the basic assumption that buyers shouldn't pay more for a property than it would take to construct a similar one from the beginning.
Comparable company analysis (CCA)
CCA is a method for determining a company's valuation by comparing its KPIs to those of other businesses in the same industry and size range.
The term reflects the concept that similar firms would have comparable value multiples, which forms the basis of comparable company research activities.
Compounding
Compounding is the reinvestment of earnings to generate more earnings, making your investments grow exponentially over time. Both the initial investment and the total prior investments will be used to calculate future returns.
Current value method (CVM)
CVM is a valuation methodology that is calculated by deducting the value of the preferred classes based on their liquidation preferences or conversion values; the Current Value Method calculates the overall equity value of the company on a controlling basis.
Common stockholders then receive the remainder.
Date of Valuation
Also known as the Valuation Date, Measurement Date, and Appraisal Date. Refers to the specific date on which an asset's value is established.
Debt Financing
Debt financing is raising capital by borrowing money and paying it back in the future along with interest (ex: Loan). The loan usually is granted based on the value of the company assets.
Discounted Cash Flow (DCF)
DCF is a valuation method that uses future cash flow projections to estimate the value of a firm.
Direct Sales Comparison Method
Direct Sales Comparison Method is a valuation method based on the assumption that an investor will pay no more for a particular asset than the cost of acquiring another equivalent one.
Dividend
A dividend is a periodical distribution of earnings made by a corporation to its shareholders. The financial ratio of yearly dividend payments.
Discount for Lack of Liquidity (DLOL)
To put it simply, a Discount for lack of liquidity is a term that refers to the sum or a proportion added to the value of an ownership stake to represent the relative inability to swiftly turn an investment into cash.
Distributor Method
When the acquired entity's relationship with its customers is comparable to that between a distribution company and its customers, the Distributor Method, a version of the MPEEM, may be applied.
Diversifiable Risk
The probability that a security's price would change as a result of its unique qualities is known as diversifiable risk. An investor's portfolio can be diversified to minimize this kind of risk.
Earnings Before Interest and Taxes (EBIT)
EBIT is a way to gauge a company's profitability. It is determined by deducting all costs—with the exception of interest and taxes—from the revenue.
Enterprise Value (EV)
EV reflects the total value of the equity in a business along with the value of its debt or debt-related liabilities, knowing that cash or cash equivalents that may be used to pay for such liabilities are not included in the calculation.
Equity
Also Known as “owners' equity”, “stockholders' equity”, or “shareholders' equity”. It is the asset's value after all obligations have been deducted. The difference between a firm's obligations and assets on its balance sheet indicates how much equity the company has.
The equity value is calculated using the share price or a value established by valuation specialists or investors.
Equity Risk Premium
The extra return that stock market investing offers above a risk-free rate is referred to as the equity risk premium. Investors receive payment from this extra return for accepting the comparatively higher risk of equities investment.
Equity multiples
Equity multiples is a term that refers to comparing ratios between the share price of a firm and a measure of its performance, such as profits, sales, book value, or a comparable metric.
Excess earnings method
The excess earnings method is an income valuation approach in which the evaluator has to determine the value of tangible assets, estimate a suitable return on those assets, and then deduct that return from the business' overall return to leave the "excess" return, which is assumed to come from intangible assets.
Exit Price
Exit price is the price that would need to be paid or received in order to transfer a liability or sell an asset.
Fair Market Value (FMV)
When transferring ownership of a property on the open market from a seller to a buyer, who is both informed about the asset and acting in their best interests, not under any compulsion to buy or sell, and has the time to complete the transaction, then such a transaction value is referred to as fair market value.
Free Cash Flow to Equity (FCFE)
A company's free cash flow to equity ratio measures how much cash is left over after all costs, investments, and debt have been paid.
In other words, it is the cash flows left over after supporting business operations and making essential capital investments that can be distributed to stockholders and debt investors.
The Formula for FCFE:
FCFE= cash from operations - Capex + Net debt issued
Functional obsolescence
In simpler terms, the loss of an object's value caused by an obsolete characteristic difficult to alter or change is referred to as functional obsolescence. When it comes to long-term business planning, most firms take this term into account.
Going concern value
Going concern value is a valuation methodology that believes the company will keep operating profitably in the future (ongoing business).
Intangible parts of Going Concern Value result from variables such as having a trained workforce, loyal customers, licenses, processes, and procedures in place.
Goodwill
Goodwill is the difference between going-concern value and liquidation value. It is the intangible value resulting from a company's name, reputation, customer loyalty, location, products, and other unidentified variables.
Greenfield Method
Greenfield is most commonly used when valuing an intangible asset. The Greenfield Method, one of the income approach methodologies, is based on the discounted cash flows of a hypothetical start-up corporation that has no assets but owns the specific intangible asset being valued.
Hurdle Rate
A hurdle rate is the needed minimum rate of return on investment. A low-risk hurdle rate implies a low risk, whereas a high-risk hurdle rate implies a high risk.
Intangible Assets
An intangible asset is an on-physical and long-term asset that expands in value year after year and grants rights and advantages to the owner (e.g., client loyalty, artistic, contract and technology-related, Goodwill, brand recognition, patents, trademarks).
Investment Risk
Investment risk is a term that measures the degree of uncertainty in reaching the expected returns on a specific investment.
Key Person Discount
The key person discount is related to the individual's operational expertise and reputation in the business, both of which can support the sustainability of income and cash flow in the future.
If there is a chance that the key person's absence may reduce the fair market value of the company or the shares being valued, the influence of the key person on the value of the business entity is accounted for as a discount or included in the future income streams.
Liquidation Value
The liquidation value of a corporation is the net value of its tangible assets if the business is terminated and the assets are sold separately.
The liquidation value is the amount paid for the company's real estate, equipment, and inventory. Intangible assets are not included in the liquidation value of a corporation.
Liquidity
Liquidity is the capacity to swiftly, cheaply, and with a high degree of certainty realize the anticipated amount of revenues from an asset, business, or investment.
Market Cap
Market Cap, or Market Capitalization, refers to the total market value of all stock shares of a firm. It is calculated by dividing the total number of shares by the stock price.
In other words, it represents the total value of a publicly listed company's issued shares owned by investors.
Market Risk
Market risk is the danger of losing money on financial assets due to market fluctuations. Changes in equities or commodity prices, interest rate movements, or currency volatility are all examples of market risk.
Net Debt
A company's ability to pay off all of its debts if they were due right away can be assessed using the liquidity metric known as net debt. Net debt displays the ratio of a company's balance sheet debt to liquid assets.
Risk-free rate
The market rate of return on an investment that is free of default risk. Even if it is impossible to get a risk-free rate, it is determined by subtracting the current inflation rate from the yield on the Treasury bond that corresponds to the investment timeframe.
Sustainability
Sustainability is an investigation of aspects such as (but not limited to) the environment and climate change, health and well-being, and corporate responsibility that may or may not impact asset value in general. It is a pledge to carry out activities in a manner that does not destroy resources or have harmful consequences.
Tangible Assets
In contrast, intangible assets are physical assets such as cash, accounts receivable, inventory, property, plant, equipment, etc.
Valuation
Valuation, also known as appraisal, is the analytical procedure of determining the value of an asset, business, or investment.
Business Valuation Glossary FAQs
Market participants are people who buy and sell in the primary market for an asset or liability.
It is the difference between the value of all physical assets and intangible assets. It is also referred to as “book value”.
The money gained by an investment before deducting costs like taxes, investment fees, and inflation is known as the nominal rate of return.
The amount of capital a company maintains for its ongoing operational requirements is frequently calculated as the difference between current assets and current liabilities.
Normalized earnings are normalized or adjusted to remove the effects of one-time profits and losses to determine a company's genuine earnings from typical operations.
The P/B ratio calculates a company's market valuation compared to its book value.
(Book Value = company's total assets minus total liabilities)
WACC is determined by averaging the interest rates from all of the company's capital sources, including debt and equity, and weighting the average based on the proportional value of each source.
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